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With concerns about AI trading rising and cryptocurrency volatility soaring, traders who have a bullish long-term outlook for their holdings but are concerned about short-term declines can use futures to manage their risk.
Just as the origins of futures markets can be traced back to farmers who needed to hedge their crops, hedging remains an important feature of futures markets for all kinds of participants, from airlines hedging oil prices to individual investors wanting to hedge their retirement portfolios.
Why hedge?
Hedging using futures allows traders to manage portfolio risk in the event of an economic downturn. As the value of their holdings falls, the value of short-term futures contracts rises, offsetting some of their losses. Leveraged futures offers allow you to hedge large portfolios with relatively low initial margin requirements.
Long-term investors looking for comprehensive protection for their retirement portfolio can use S&P 500 Index futures to hedge against downside risk. However, given that approximately 70% of the Nasdaq 100 is made up of either the Magnificent 7 or tech stocks, if you are particularly concerned about AI risk or a decline in the Magnificent 7, selling Nasdaq 100 futures contracts may provide a broader hedge against a potential AI decline.
Different contract sizes are available depending on the size of the position you wish to hedge.
For example, if you want to hedge a $50,000 position in a Nasdaq 100 company, the micro E-mini Nasdaq 100 futures contract (/MNQ) has a multiplier of $2. So, if the Nasdaq 100 is trading at 25,000, the notional value of one /MNQ contract is $50,000 ($2 x 25,000).
Let’s say the Nasdaq 100 drops 5%. Your long position is currently worth $47,500. However, if you sell one /MNQ contract, the value of your short futures position is theoretically: rise In this case, you would make a profit of $2,500 by buying back the futures sell contract.
For traders with large holdings of cryptocurrencies, cryptocurrency futures are also available for a variety of coins, including: Bitcoin, Ethereum, XRPand Solana.
This summer, CME Group will begin trading individual stock futures on more than 50 major U.S. stocks, giving traders the ability to further tailor their hedges for larger exposures. Nvidia, alphabet, metaetc.
hedging risk
Although hedging provides downside protection, there is always a risk that the position will move up, in which case losses on the short position will erode the gains on the long position. For this reason, traders may choose to hedge only a portion of their portfolio.
After all, hedging functions much like insurance. I hope I never have to use it, but in the unfortunate event that it happens I’ll be very happy to have it.
